Portlandia

Topics: 1985, 1945, May Pages: 17 (942 words) Published: November 23, 2014
The Strategy and Value of a New Venture:
The Case of Portlandia Ale
a supplement to
“Uncertainty: The New Rules for Strategy”
Journal of Business Strategy
May/June 1999
Glaze Creek Partners

Page 1
May, 1999

Note:
This example is taken from
Chapter 10 of
Real Options: Managing Strategic Investment in
an Uncertain World (HBS Press, 1999)
by
Martha Amram and Nalin Kulatilaka
Glaze Creek Partners

Page 2
May, 1999

A Step-by-Step Example

PORTLANDIA ALE:
❒ Two brewmasters and a dream
❒ Their business plan is straight DCF
❒ The reality is that firm has options
❒ Let’s calculate the expanded value of the firm:
V = DCF + option value

Glaze Creek Partners
© HBS Press, 1999. From Chapter 10, Real Options: Managing Strategic Investment in an Uncertain World

Page 3
May, 1999

Portlandia Ale’s Business Plan

Fixed Cash Flow
Optional Cash Flow

Spend $0.5M per quarter
on product development

Raise
$4M

If Launch,
Obtain Value of an
Established
Brewer

x
Spend $12M on
Market Launch

Year 1

Year 2

Year 3

Glaze Creek Partners
© HBS Press, 1999. From Chapter 10, Real Options: Managing Strategic Investment in an Uncertain World

Page 4
May, 1999

Even with optimism, spreadsheet calculations
show that the DCF value is negative

Value of Portlandia Ale using discounted cashflow = ($0.23M)

Time
Y1-Q1
Revenues
Investment
(0.50)
Terminal Value
PV (Investment)
(0.50)
PV (Terminal Value)
DCF Value
($0.23)

Y1-Q2

Y1-Q3

Y1-Q4

Y2-Q1

Y2-Q2

Y2-Q3

(0.50)

(0.50)

(0.50)

(0.50)

(0.50)

(0.50)

(0.49)

(0.49)

(0.48)

(0.48)

(0.47)

(0.46)

Y2-Q4

Y3-Q1
1.5
(0.50) (12.00)
22.00
(0.46) (10.86)
14.46

Terminal Value =
$1.5M quarterly rev. x 4
x 3.66 (Market to sales ratio)
Glaze Creek Partners
© 1999, Amram and Kulatilaka. Downloadable file at www.real-options.com

Page 5
May, 1999

But there is no obligation to launch the product,
only an option
❒ DCF has two parts


“Hardwired” investment schedule



Single roll of the dice on revenue

❒ Recognizing the option to launch




Multitude of outcomes
Optimal response to each outcome, including the no
launch decision

Glaze Creek Partners
© Amram and Kulatilaka, 1999.

Page 6
May, 1999

Valuing the option to launch

❒ Black-Scholes formula was part of the Nobel
Prize winning breakthrough
❒ When applicable, the Black-Scholes formula is
an easy-to-use and quick “option calculator”
❒ Beauty of formula




No-arbitrage pricing
Only five inputs
No forecasting

Glaze Creek Partners
© Amram and Kulatilaka, 1999.

Page 7
May, 1999

Inputs to the Black-Scholes formula for the
option to launch
The option to launch

Call option on a stock

Current estimate of
value of microbrewery

S

Stock price

Cost of launch

X

Exercise price

Launch date

T

Exercise date

Time value of money

r

Risk-free rate of return

Volatility of value

σ

Standard deviation of return
on the stock

Glaze Creek Partners
© Amram and Kulatilaka, 1999.

Page 8
May, 1999

The value of the option to launch is calculated
using the Black-Scholes equation
Definitions

The Black-Scholes Equation

F=

N(d1) S -

Expected value
of launch, if launch
Expected value of S if
S > X at T

N(d2) X e -rT
Probability of launch
times
PV of cost of launch
Probability of S>X at T
times
PV(cost of investment)

F=
S=
X=
r =
T=
σ=

Current value of call option
Stock price
Exercise price
Risk-free rate of return
Time to decision date
Volatility of the stock return

N(d1) and N(d2) are the value of the
normal distribution at d1 and d2
d1 = [ln(S/X) + (r + 0.5 σ2)T ]/ σ√ T
d2 = d1 - σ√ T
“Probabilities” refer to risk-neutral
probabilities

Glaze Creek Partners
© HBS Press, 1999. From Chapter 8, Real Options: Managing Strategic Investment in an Uncertain World

Page 9...
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